QUESTION 3 a Once an item of Property Plant and Equipment PP

QUESTION 3 a) Once an item of Property, Plant and Equipment (PPE) has been brought to working condition for its intended use, how should any subsequent expenditure on the item of PPE be treated from an accounting perspective? Under which conditions should subsequent expenditure in relation to an item of PPE be capitalised or expensed? Provide examples to illustrate your arguments 5 marks b) Which of the following costs should be included in the cost of an item of property, plant and equipment (PPE) at initial recognition? The purchase price of the item II. Import duties incurred in relation to the item II. Delivery charges M. Minor spare parts for the item V. The cost of a maintenance contract VI. Non-refundable purchase taxes relating to the item If any of the above costs are not to be included in the cost of an item of PPE at initial recognition, explain how they should be treated from an accounting perspective 4 marks c) On 1 January 20X1, Barbosa Ltd purchased an item of plant for £300,000 which was to be depreciated over its useful life of 10 years (straight-line, no residual value). On 1 January 20x5, the plant was revalued to its fair value of £600,000, with no revision to its remaining useful life. On 1 January 20x6, the plant was sold for £700,000 In accordance with IAS 16 Property, Plant and Equipment, explain the accounting entries required to record the revaluation on 1 January 20xs and compute the profit/loss on disposal to be included in Barbosa Ltd\'s income statement for the year ended 31 December 20X6. Provide clear workings. 6 marks

Solution

a. Per IAS 16, any subsequent expenditure incurred to add to or replace part of or service an asset which has been recognized as PPE should be capitalized. However, the condition is that the expenses incurred meet the recognition criteria, i.e., It is probable that the future economic benefits will flow to the entity from the asset and the costs can be measured reliably. Such costs can be capitalized only if these are enhancing the economic benefits originally assessed.

Example 1: Minor repairs to a machine - should be expensed as and when incurred

Example 2 : If a part of the asset needs replacement, cost of the replacing part can be added to the carrying amount of the PPE item. At the same time, the carrying amount of the the part that is replaced will have to be de-recognized

b. At initial recognition, the following costs are included:

1. Purchase price of the items

2. Import duties related to the items

3. delivery charges

4. non- refundable purchases taxes relating to the item

the other two items are not recognized as cost of the asset:

1. Minor spare parts - these are usually used to replace parts already existing and do not add to the future economic benefits that will flow to the entity

2. Maintenance contracts - are expensed over the period of the contract and are recognized as prepaid expenses on the balance sheet

c. The written down value of the asset as of 1/1/05 is:

Cost of the asset = 300,000

Life = 10 years

From 2001 to 2005, the asset is depreciated on a straight line basis for 5 years = 300,000/10*5 = 150,000

Written down value = 150,000

The asset is revalued at 600,000, surplus being 450,000, the journal entry will be:

Asset A/c Dr 450,000

To Revaluation surplues 450,000

This gain is shown as OCI.

On 1/1/2006, the asset is sold for 700,000.

WDV as of 1/1/06 = 600,000 - (600,000/5) = 480,000

The gain on sale = 220,000 is recognized in the p&l

The original revaluation surplus is transferred to retained earnings or alternatively can be retained under revaluation surplues, but cannot be passed thru P&L

The journal entry will be:

Bank account dr 700,000

To Fixed Asset 480,000

To Gain on sale of asset 220,000

d. Per IAS 2, Inventory is value at lower of cost of Net realisable value:

NRV of the product is:

Cost of the finished goods is 30, NRV is lower than the cost, hence it will need to be written down by (1,000units *4) = 4,000

Work in progress:

Cost as of period end = 25

Additional cost to be incurred = 2.5

Total cost = 27.5

Net relisable value = 26

The 2,500 units will have to be written down by 1.5 per unit (2,500*1.5= 3,750

Since the finished goods are written down to lesser than the cost, the materials will need to be written down too to the replacement cost. This is considered as the best available measure of NRV.

The work in progress will be stated at 2,500*23.5 = 58,750

Finished goods at 1,000*26 = 26,000

Selling price per unit	35
Less: Discount @20%	7
Less: Additional selling expense	2
Net realizable value	26